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Abel, Financial Executives Institute

Testimony of James J. Abel

Executive Vice President and CFO

Lamson & Sessions

on behalf of

FINANCIAL EXECUTIVES INSTITUTE

before the

President's Commission to Study Capital Budgeting

May 8, 1998

Good afternoon. I would like to thank the Co-chairs,
Ms. Brown and Mr. Corzine,, for the invitation to be here today. My name
is Jim Abel. I am Executive Vice President and Chief Financial Officer
of the Lamson & Sessions Company in Cleveland, Ohio. I am also the
incoming Chairman for Financial Executives Institute, a professional association
of 14,000 chief financial officers, treasurers, and controllers from over
8,000 public and private corporations throughout the United States and
Canada.

I appreciate the opportunity to present the views
of FEI before this presidential commission and, further, I wish to convey
FEI's willingness to provide technical assistance to you and your staff
during the course of your work on this very important subject.

Why Capital Budgeting?

As many of you may know, the private sector has gone
through a wrenching process of re-engineering and downsizing over the past
15 years. Virtually every business has had to reassess its mission, priorities,
and the ability to deliver a required level of goods and services at a
lower cost and with greater efficiency. Those of us in the corporate financial
community know how critical and painful this process can be. We had to
do it because of the efficient laws of survival in the global marketplace.
During this period of multi-billion dollar budget surpluses, we strongly
recommend that the Federal government emulate the private sector experience.

Central to private sector re-engineering has been
employment of a highly disciplined mission definition and capital allocation
process conducted in a prescribed cycle schedule. Pivotal to these efforts
is the commitment to long-term fixed assets which will drive much of the
operating budgets of future years.

The importance of capital budgeting in the private
sector cannot be overemphasized. Capital budgeting forces companies to
develop long-term strategies on how most efficiently to accomplish their
business objectives and to link cost to the fulfillment of that mission.
By doing so, it subjects the process to serious analysis for setting
priorities and allocating scarce resources.

Given the impact on long-term mission accomplishment
and the financial commitments which are embodied in the capital budget,
ft is imperative that it be analyzed, approved and accounted for in a process
totally separate from that for current operations. To lump them together
as is currently done in the Federal unified budget is to obscure and frustrate
the role it should play.

It must be understood that the presentations accompanying
the approved Federal budgets that break out capital appropriations for
fixed assets and the other "investments" are done after the fact and are
not separately considered in the decision-making process. Taking this approach
makes it virtually impossible to adopt the disciplined approach of the
private sector to define the mission and allocate capital appropriately
in support of it.

The Mission Definition and Capital Allocation Cycle

Capital budgeting forces companies to develop a long-term
(usually five years) strategic plan to fulfill stated goals and objectives.
In developing the strategic plan, companies first determine what their
capital asset requirements will be to accomplish the mission. Once completed,
the costs to fund the capital assets will be calculated.

Determining the ability to fund capital projects
requires companies to prioritize projects in order to accomplish the stated
objectives and best fulfill the overall mission within funding constraints.
In the private sector, companies utilize analytical tools, such as positive
net present value, to evaluate investment criteria and determine the relative
value of competing projects and to make the critical priority decisions.

Once this process is complete and the decision to
move ahead with the capital investment is made, a system must be put in
place that periodically tracks the progress of the investment's critical
path to ensure that the project is meeting its stated objectives in a timely
manner and within prescribed expenditure limits.

In the private sector, the financial reporting system
is used to monitor the progress of such capital projects - produced on
a monthly, quarterly, and annual basis. Safeguards such as periodic audits
are performed regularly to ensure the accuracy of the financial reporting
system and accomplishment of objectives.

In condensed form, these reports are then reviewed
by executive management and often by a board of directors to evaluate the
effectiveness of the strategic plan and the underlying capital investments.
The board of directors uses this information as the basis for approving
the strategic plan for the ensuing five years, with annual reviews to assess
its status and make modifications where appropriate. This process helps
to ensure that the implementation stays on track and provides the flexibility
to adjust to a change in conditions.

If the process is adopted as FEI proposes, this review
and approval would be done at the federal level by Congress through its
oversight committees on Governmental Reform and Oversight and Governmental
Affairs.

Definition of Capital Assets

A distinction must be drawn between the broad concept
of federal investment spending for long-term benefits and the included,
but more narrow function, of the planning, executing and tracking of physical
capital asset acquisition. Of the proposed 1999 investment spending of
$237 billion, $77 billion would be for research and development, $50 million
for education and training and $113 billion for physical capital. While
unquestionably vital to future development of the country's potential,
FEI would propose that the first two categories be separated from the conceptual
framework for capital budgeting we would propose to explore.

It should also be noted that of the $113 billion
of physical capital, $50 billion will be for national defense, $19 billion
for non-defense and $44 billion for grants to state and local government
for infrastructure projects they would own and operate. This last category
is effectively expensed despite its long-term nature. While we feel it
is important to recapture oversight of these investments, the associated
accounting complications require this to be a later effort. However, there
are ways that a parallel effort involving federally-owned projects could
provide important insights.

Within the $50 billion of defense expenditures, a
significant portion representing weapons systems will be categorized as
stewardship assets and effectively expensed. This is dictated by Financial
Accounting Standards Advisory Board pronouncements citing a variety of
concerns. Among these is the uncertain life of weapons systems committed
to hostile utilization environment which precedes reasonable, predictable
lives and hence gives rise to questionable depreciation schedules. While
FEI appreciates these concerns, we believe that it is possible to deal
effectively with these assets and would propose to explore several concepts.

Based on our thinking on these matters, FEI would
urge consideration of three pilot projects that could be useful in examining
alternative approaches to current procedures in the area of capital budgeting.

Within the Mission Definition and Capital Allocation
process, decisions must be made on the present and future deployment of
various categories of capital investment which support mission accomplishment.

Embracing all of the definition of investment which
is applied to all federal programs within the current conceptual framework
would obviously overwhelm the effort. Therefore, FEI has chosen to narrow
the definition initially to tangible fixed assets and to address a limited
number of program types.

This would include:

Defense system procurement,

Building, equipment and information systems to support agency operations,
and

Government-owned infrastructure projects

We would not include such items as:

Intangible assets

Grants to state and local governments

Revolving funds

R&D, education and training

Human Resources

Social Investment

FEI Recommendations for a Pilot Program

Because of the long-term commitments created by the
capital budgeting process for fixed assets, it is essential that ft be
analyzed and justified in a process separate from that used for other forms
of federal investment, current operating expenses and discretionary spending.

However, moving to capital budgeting does raise some
additional issues. These include violating existing policy and law concerning
the appropriation process, the inclusion of depreciation in operating budgets,,
employment of deficit financing of investments and possible abuses such
as deflecting costs between operating and capital accounts!

While recognizing these concerns, FEI believes that
it is possible to create systems that would deal effectively with each
of these issues. This would include protecting the concepts of full funding
and up-front scoring along with retention of the visibility of the unified
budget. To that end, FEI has proposed to Congress a pilot program to test
the applicability of these systems to discrete federal programs that are
representative of three classes of fixed asset investment:

A major weapons system procurement

An information system acquisition, and

A government-owned infrastructure project such as power generation

Each project would create and implement a Mission Definition
and Capital Allocation program. It would then establish a proposed fixed
asset Capital Budget distinct from other investment and spending for associated
department or agency. Following that it would integrate the fixed asset
expenditures budget with other appropriate investment and spending relevant
to the program. A financial management and control system would be devised
with an accompanying reporting and auditing program to be presented for
oversight approval.

Systems and procedures would be devised and tested
to prove their efficacy and their ability to satisfy the concerns expressed
by observers. Each of the three programs would then be evaluated for possible
broader application and, hopefully, eventual adoption as modified and improved
for general use in the Federal budget.

Conclusion

Budget decisions made today have long-term ramifications
for the health of the nation's economy. In this current budget environment,
making informed budget decisions could mean the difference between sustained
surpluses or a return to multi-billion dollar deficits. This is where capital
budgeting can play a vital role. Capital budgets would be important
tools for Congress and the President to have at their disposal as they
work toward a more efficiently-run government.

1.) It provides a means to improve the prioritization
of capital spending and ensure that prescribed goals are achieved.

2.) It will enhance the understanding and communication
among those individuals charged with implementing these projects.

3.) The capital budgeting process will provide a
disciplined approach to this critical spending necessity which allows for
a coherent review component and accountability for the results.

Clearly, there are important and obvious differences
between managing the government and managing corporations. However, this
does not mean that sound business management practices cannot be applied
to government. It is in all of our best interests to see that government
revenues are spent in efficient and cost effective ways. We believe that
the Capital Budget process played a crucial role in helping corporations
make the right investment decisions which have helped to transform our
global competitiveness. We believe that it can play a similarly crucial
role for the government as well.

To that end, FEI has worked for over 15 years promoting
the need for improved financial management practices in Federal government.
Seven years have passed since the passage of the Chief Financial Officers
Act of 1990. Much has been accomplished, but much more remains to be done.
We believe this period of prosperity provides a unique opportunity to significantly
improve Federal Financial Management while at the same time taking a long,
hard look at updating the Federal Budget Process. The time is right to
get the Federal government's fiscal house in order, and we stand ready
to assist this Commission to accomplish these long overdue objectives.

Thank you for this opportunity to appear before the
Commission this afternoon. I would be pleased to answer any questions.